Dollar General's Got It, Wal-Mart's Getting It, and Target's Looking For It

I wrote a few articles in December about a new trend emerging: small-box retail shops have better same-store sales than large-box retailers. The article compared the recent earnings performance of Wal-Mart  (NYSE: WMT  ) and Target (NYSE: TGT  ) with that of Family Dollar Stores and Dollar General (NYSE: DG  ) . The dollar stores had better same-stores sales growth than either of their large-box retail compadres. As you can see from the graph below, even though Family Dollar had a bad first quarter, the trend hasn't set in like it has for Target.

TGT EPS Diluted (TTM) Chart

Target EPS Diluted (trailing-12 months) data by YCharts

Prior to the data breach, for the first nine months of the year, Target reported same-store sales growth of 0.5%; the same metric for the entire year dropped to negative 2.7% compared to a 0.5% increase in the prior year. Both before and after the data breach, Target could have used some advice from smaller-format stores like Dollar General on how to increase traffic.

One thing is certain: smaller-format stores focus on consumables, or items that people buy several times a week, like food and tobacco products. The consumables market segment, especially food, has been one of the fastest-growing categories among discount retailers. Small stores focus on consumables because they have limited space, and the discount-retail model thrives on high volume. The best way to keep that volume going is by filling stores with items that people consume.

Unlike Wal-Mart and Target, Dollar General's same-store sales increased by 3.3% in 2013. Consumables accounted for an incredible 75% of sales, which drove 89% of the total sales increase. The tobacco, candy, and snacks segments had the most significant increases.

It took some time, but Wal-Mart gets it now. The company's own research shows that smaller-format locations get better results than larger supercenters. Fourth quarter same-store sales declined 0.4% overall but rose approximately 5% at smaller-format stores.

In February, the new CEO committed to the addition of 270 to 300 small stores, doubling the initial forecast of 120 to 150 stores. The strategy not only increases sales but transforms the business model to something that can grow without cannibalizing supercenter sales. Wal-Mart plans on leveraging supercenters as supply chain/warehouse centers for the smaller-formats stores, which is truly ingenious.

Takeaway
It's not too late for Target's management to take tips from Dollar General, like Wal-Mart did. One thing is certain: Target must do something to make better use of its floor space. By example, Dollar General has provided two strategies to help Target increase same-store sales growth:

  1. Focus on consumables
  2. Build smaller-format stores

Wal-Mart gets it. It didn't last quarter, but now it does and the new CEO is moving fast to make small stores his legacy. One good thing about Target is that its gross margin is better than most in the industry, so one bad year won't hurt much. But if the company doesn't get it right soon, the brand and the stock could suffer.

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